MarksJarvis: Shutdown can't rattle stocks

Investors have heard the boy cry wolf too many times in the nation's capital. And they aren't falling for it this time.

October 01, 2013|Gail MarksJarvis

Markets on Tuesday seemed unfazed by the federal government shutdown as experts said the economic effects would probably be limited. (Scott Eells, Bloomberg)

Game's up.

Investors have heard the boy cry wolf too many times in the nation's capital. And they aren't falling for it this time.

There was no panicked selling in the stock market over the federal government's temporary shutdown.

The government began closing about a third of its operations Tuesday, and investors went their merry way and ignored it. The Dow Jones industrial average rose 62 points to 15,191 despite the shutdown.

The expectation is that politicians will stage their dramatics for a while longer, but within a few days this dysfunctional crew will cobble some solution together to keep the government running and make sure the government's bills are paid. About 800,000 workers who are going on furlough will be brought back to their government jobs and receive back pay. Contracts will get paid, and government business will start up again as usual.

If investors are correct about this benign scenario, there will be little long-term impact on the economy or stocks. Investors have seen the debt-battle script performed repeatedly since the August 2011 feud over the nation's borrowing and a downgrade by Standard & Poor's sent stocks down about 7 percent in a day. Since then, neither mandatory budget cuts under "sequestration" nor Jan. 1's "fiscal cliff" has delivered the dire consequences threatened by grandstanders.

The investors who panicked and sold stocks amid the theater over the nation's debts missed solid recoveries in the stock market soon after. Since Congress agreed on a last-minute deal to extend the debt ceiling in 2011, the Dow Jones industrial average has climbed about 41 percent.

With all the last-minute deals in mind from the past two years, investors have not responded much to the threat of the current shutdown. During the week leading up to Tuesday's shutdown, the stock market declined about 2.5 percent as investors secured some of the 18 percent gains they had earned in the stock market this year. But the general response has been to hold on and ignore the politicians.

"We do not expect to see long-term damage to the economy from a shutdown — particularly one lasting less than seven days," said JPMorgan strategist Thomas Lee. "And most investors tend to agree."

In the 18 shutdowns since 1976, stock market losses during shutdowns of eight days or less have been no greater than about 2 percent, Lee said. If the shutdown lasts longer, uncertainty builds, but even the worst declines have only been as great as 4.4 percent, and sometimes there have been no losses. On average, stocks decline just 0.8 percent during shutdowns and climb 2.8 percent 90 days after the shutdown.

Yet, the current debate is only the opening act in a longer drama. The next act could be more unnerving. Congress will be asked around mid-October to extend the nation's debt ceiling.

In the worst-case scenario, investors worldwide could lose confidence in the U.S. to pay investors in Treasury bonds, and that would make it more difficult for the U.S. to borrow money at affordable prices. Ultimately, higher borrowing costs would aggravate the country's debt problems and put more pressure on the U.S. to make cuts in services or raise taxes.

So as the deadline approaches to raise the debt ceiling around Oct. 17, investors are expected to be less sanguine. While that could cause more upheaval in the stock market than investors have seen so far, most analysts think politicians will act in enough time to prevent the feared government default on payments to investors in U.S. bonds. And while the U.S. already is being mocked in some of the foreign press for the debt spat, analysts think it's unlikely that global markets will lose confidence in Treasurys.

The U.S. government has more leeway now to cover its debts than officials are letting on, said Jim Bianco, president of Bianco Research.

Even if Congress doesn't extend the debt limit by late October and the government temporarily isn't allowed to sell additional bonds to cover its obligations, Bianco figures that the government will have enough tax revenue to make its payments to bondholders on time and avoid panicking markets.

He figures the government will need to pay about $25 billion a month on its debts, while taking in about $150 billion to $170 billion in taxes that can be devoted to those payments. On a longer-term basis, the government must grapple with all its expenses, including about $70 billion for Social Security and $30 billion for the military, said Bianco, but in the short term the government "can prioritize" without a default.

Bianco thinks analysts have done the math and that's why there has been little fear in the markets about the U.S. defaulting on bond payments.

Meanwhile, he figures that as the deadline for extending the debt limit draws near, all it will take is a 300- to 400-point drop in the stock market to stop the feuding and get an agreement that will get the nation through the most recent funding hump. He credits a slide in the stock market at the end of December for political leaders "freaking and putting together a deal in a few hours" to avoid the fiscal cliff Jan. 1.